Cryptocurrency has come a long way since the introduction of Bitcoin in 2009. When cryptocurrency first burst onto the scene, many people dismissed it as a fringe technology. Since then though, it has grown into a global financial phenomenon with thousands of different digital assets now available for people to purchase, a multi-trillion pound market car and the technology used in cryptocurrency is being adopted by businesses, investors and even some governments.
But there is still one question that people are asking. What gives cryptocurrency its value?
In todays blog we are going to answer this, we are going to break down how value is determined in any asset and then apply that came thinking to cryptocurrency.
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Crypto supply.
One of the main factors that give anything value, whether it is gold or real estate is supply and demand. If something is rare and there are people that want it, it tends to become more and more valuable. This idea is at the heart of many cryptocurrencies.
Bitcoin, for example has a fixed supply of 21 million coins. No more can ever be created, regardless of the demand for the token. This built-in scarcity is designed to mimic precious metals such as gold. The more people that want Bitcoin, the more the supply drops, naturally increasing the value.
There are other cryptocurrencies that also use the supply constraints to help create value. Ethereum doesn’t have a “hard cap” like Bitcoin, but it is moving toward mechanisms that reduce the supply over time. This is achieved by “burning” small amounts of Ethereum in transaction fees. This logic, much like with Bitcoin works to limit or decrease the supply, in turn increasing the value as the supply lessens and demand grows.
Utility and use cases.
Having a smaller supple than the demand requires isn’t enough on its own. Cryptocurrencies also need to have utility to be valuable. Utility, meaning the base use case for the token, what you can actually do with the cryptocurrency.
There are many tokens that have clear use cases, below are some of the more obvious ones;
– Ethereum (ETH) – Ethereum is used to pay for transactions and computational services on the Ethereum network, which supports decentralised applications and smart contracts.
– Chainlink (LINK) – Chainlink provides decentralised oracle services. This means it helps smart contracts access real-world data.
– Stablecoins – Stablecoins, such as USDC and Tether are used for trading cryptocurrencies, lending and transferring value without the normal volatility of other cryptocurrencies.
Trust and decentralisation.
Trust is a big factor in determining a value for anything these days. Traditional currencies, like the pound or the dollar are backed by governments and central banks. People trust traditional currencies because of the stability and authority that is behind them.
Cryptocurrencies do not have this and have grown to offer a different kind of trust. This trust is built on decentralisation and transparency. The value comes from the fact that no single entity controls the network. Transactions completed on the blockchain are verified by a group of participant and the rules for the transaction are set in the code of the smart contract. This makes censorship, fraud or any kind of manipulation much harder to accomplish.
For example, one of the reasons Bitcoin is value so highly is that the network is extremely secure and has ever been hacked. Its decentralised nature and consistent operation for longer than a decade has built a strong trust with its user base.
People using the network.
The more people who use a particular cryptocurrency or network the more useful and valuable it will become. This is referred to as “network effect”. Just like social media platforms become larger and gain more public attention with more users, cryptocurrencies often become more valuable as the adoption spreads.
A great example of this is Ethereum. As more developers build applications on Ethereum, and more users interact with those applications, the demand for Ethereum (ETH – the currency needed to operate on the network) goes up, which in turn with increase the value of Ethereum.
Network effects also apple to Bitcoin. As more of the global financial institutions adopt Bitcoin, and more retailers begin accepting it as a valid payment method, it becomes easier to use and reinforces its overall value.
Speculation and market sentiment.
One of the biggest driving forces behind a cryptocurrencies price is speculation, especially in the short-term. Prices can be altered by investor interest, media coverage, hype cycles and even tweets and other social media posts from influential people.
Speculators bet on the future value of a cryptocurrency, sometimes pushing the price far beyond what a rational people may value the token. This is why the crypto markets are so volatile. However, while speculation can create a short-term price adjustment, over time the asset in question will need to demonstrate real utility or adoption to retain its value and carry on growing.
Technology and security.
Another major factor that is taken into account is the security of the network. A strong, secure network attracts users and developers, pushing the crypto in questions value even higher.
Bitcoin is often referred to as the most secure blockchain in the crypto space, thanks in part to its massive has power (the computational energy securing the network). Ethereum, even though is has less hash power makes up the ground by having greater flexibility for smart contracts and applications. Newer blockchains that have recently emerged such as Solana, Cardano and Avalanche have focused on faster transaction speed and lower fees.
The overall strength of a cryptocurrency, including how it is able to deal with demand on the network, how it is able to integrate into other systems and its ability to resist attacks all play a huge role in its long-term value.
Crypto Analyst‘s Final Thoughts.
Like any asset on the planet, a cryptocurrencies value is ultimately determined by what people are willing to pay for it. That being said, the most valuable cryptos tend to be those that are combining strong fundamentals such as utility and security with growing adoption and community support.
As the crypto space as a whole begins to mature, we may see more focus put on real-world value rather than just “hype”. Understanding what gives these digital assets their worth is a first step in a long journey for anyone looking to invest in the crypto space.